Purification

On the pages about Charity (link to Charity chapter 3) we explained the general approach of Triple F Foundation when finding good causes for its donors. A special form of Charity is the so-called ‘Purification’ of impure income in Islamic Finance funds.

Triple F Foundation is chosen as its so-called ‘Purification’ coordinator by Parmenion Group. Parmenion Group entities Parmenion Ethical (clickable link EVD) and Evolve (clickable link EVD) have created an ethical investment concept that links Western-style ethical investing (based on the Principles of Responsible Investing of the United Nations, i.e. UN-PRI) to Islamic Finance by applying 2 filters, one based on UN-PRI and one related to Shariah-compliance.

As Elgari (2000) points out:

One of the fundamental Shariah aspects in Islamic Funds is purification, which simply means cleansing the investor’s returns from income whose source is questionable from a Shariah point of view.*

As simple as things may seem to be in theory, as complicated they are in practice. Elgari (2000) shows that there are basically not just three interpretations possible as to the extent to which pious investors and Shariah scholars would require purification (the ‘how much’ question), but there is also the issue with respect to ‘who’ should purify. For our position on both issues, see below.

Parmenion Group believed that it would be most transparent and ‘pure’ to have a third party entity coordinate things, and that is what Triple F Foundation will do as one of its task.

Before explaining our position in the ‘how’ and ‘who’ parts of Purification, we would once again like to stress that we are not the ultimate Purifier in our operational model, but mainly the coordinator of this task in close collaboration with the Fund(s), relevant Shariah boards and – if applicable – other third party decision takers.

The ‘How’ of Purification

Elgari (2000) makes it clear that there is no ‘one size fits all’ with respect to Purification. Some scholars would require only dividend income of a company or investment fund to be purified (approach 1). Others define the purification process at the overall income level (approach 2). And a third group of scholars defines it at the Asset-Liability level (approach 3).

When going from approach 1 via approach 2 to approach 3 the level of stringency increases and the annual purification cash flows would go up: definitely in the short run and most likely also in the longer term. There is also a difference between the approaches as far as ‘ease of calculation’ is concerned.

So as to avoid allegations of partiality Parmenion Group has asked Triple F Foundation to coordinate the Purification process of its ethical funds including the derivation of the approach used.

Since an investment fund is a special type of company in which capital gains and dividends from the funds (in case of a fund-of-funds) and companies it invest in are basically its operational income, we recommended the use of approach 2, i.e. Purification based on Overall Income. Approach 1 (Dividend-based) would be insufficient or just plain ‘wrong’ in case we imagine a situation of an investment fund investing in – ex-post – impure activities/funds (due to riba, i.e. interest income, and/or partial investments in forbidden sectors or activities), but with none of these activities/funds paying a dividend. In such a case we would not purify at all with the activities/funds we invested in being able to use the impure funds in the meantime for new investments. To the extent that these investments themselves would then be pure, it would be like a money laundering variation of purification. The refraining from purification due to the linkage to dividends would in such an approach – with later dividends related to the new investments now being pure again – translate into no purification at all, with part of the pure dividend income later most certainly being linked to impure income!

That is why Triple F and its advisors/Shariah scholars use an overall-income-based approach to Purification.

Note: We could have considered Approach 3 (Asset-Liability based), but felt that this would leave way too many components impossible to calculate in a complicated portfolio consisting of 10-20 or more funds with each of these funds consisting of 30-50 or more individual equity holdings. The increased accuracy of approach 3 is welcomed, but a more holistic, income-based approach is a) less costly, b) easier to derive and explain while c) a lot of the increased accuracy would get lost in unavoidable calculation mistakes, with a lot of the latter offsetting each other anyway.

The ‘Who’ of Purification

As Elgari (2000) points out, it remains to be seen WHO has to purify: the investment fund or the end-investor? Some Islamic scholars point out that it is the responsibility of the end investor, with funds just having the responsibility to be transparent about not just a) the level of income, but also b) about its purity. Quarterly reports about fund performance would in such a case include a Purification Recommendation by the advisor.

Triple F believes that there are ‘economies of scale’ in charitable funding and that the services of professionals in finding the right charities to support provide end investors with added value. There is no difference between Muslim investors and other ethical investors in this respect.

As indicated in the previous paragraph, there are differences between Muslim investors among themselves with respect to the recommended Purification approach chosen concerning the ‘what’ part of the question. At Triple F we respect the various schools of thought.

We also welcome transparency and our role in guiding investors to take those decisions that best serve their needs and beliefs. We also acknowledge that end investors might have their own good causes that they might want to support.

We have therefore recommended Parmenion Group to follow an overall-income-based approach to Purification (see previous paragraph) AND to allocate 50% of it via Triple F to approved charities and projects. The remaining 50% will be paid as ‘purification’ dividend to the end investor so that he/she can take care of it him/herself.

End investors who believe that Triple F will do a good job for them also as far as the second 50% is concerned can – of course free of charge – allocate all or part of this amount to Triple F.

The chart below gives a summary of the Purification approach that we developed for Parmenion Group’s ethical funds on the basis of Fair Investing: